Younger participants are driving up the usage of Roth 401(k)s, possibly because they realize their tax rates likely will go up as they age, but also because a new law from the beginning of the year makes conversion easier.
New conversion rules combined with more plan sponsors offering Roth 401(k)s has led to an increase in Roth 401(k) usage, particularly among younger participants, according to a new Wells Fargo survey.
In the first quarter of 2013, 10% of participants in Wells Fargo defined contribution plans chose to contribute to a Roth 401(k), up from 8.9% a year earlier. According to an analysis of two million eligible participants in a subset of retirement plans, 17% of participants contributing to Roth 401(k)s were under the age of 30, which is up from 15.2% a year ago.
“The continued upswing of Roth usage is interesting because the usage is driven by younger investors,” Laurie Nordquist, director of Wells Fargo Retirement, said in a statement. “This suggests that they are aware that their tax rates will likely go up as they age, therefore it is a good strategy to opt for the lower tax bracket now, versus waiting to be taxed at their unknown rates in their 60s.”
Part of the fiscal cliff compromise at the beginning of the year included legislation that allowed employees with 401(k)s and other defined contribution plans to convert to a Roth 401(k) without issue.
“The new rules for converting existing traditional 401(k) assets to after-tax Roth 401(k) assets may have heightened awareness of how Roth works, which could also play a role in the trends we’re seeing,” Nordquist said.
Managed products also gained popularity with nearly three-fourths of participants putting money into these products, which include target
date funds, model portfolios and managed accounts. While 89% of newly hired participants used a managed product, they put just 49% of their assets in these products.
According to Joe Ready, director of Wells Fargo Retirement, these shows that participants are treating managed products as just another fund instead of as a one-stop investment.
“If participants only put some of their assets in a managed product, they may not get the full benefit of a pre-mixed portfolio that these types of products can offer,” Ready said in a statement. “As a result, participants may actually be increasing their portfolio volatility and risks without even realizing it.”
The Wells Fargo analysis also revealed that balances rose for all participants who had been in their plan for at least 10 years. Participants ages 40 to 59 saw their balances rise 17% over two years, which is slightly more than participants in their 60s and those in their 30s.
During the first quarter of 2013 more participants increased than decreased the amount they put into their defined contribution plan.
“We saw the most improvement among people who had been hired in the last two years, which is traditionally a group that is hardest to get to contribute at a rate above the common 3% default deferral rate,” said Nordquist.